Let the Punishment Fit the Harm

As a recent BBC documentary has suggested, the banking crisis involved incompetence, fraud, or some toxic mix of both. The criminal law is often concerned with the distinction between evil, mental illness, and stupidity, and perhaps those mens rea issues should inform investigations into entities like ratings agencies or investment banks. Yet given the degeneration of corporate ethics, scrutiny of these managers’ states of mind might prove as fruitless as it would be endless. The main threat these people now pose is their ongoing undue influence on our political system–for their nonstop cultivation of Congress and the White House has turned out to be the wisest investment they ever made. And the lobbying continues, as intensively as ever.

Too many bankers and other lenders have been focused on trying to beat the system by getting around accounting and banking regulations (through what is called accounting and regulatory arbitrage). Indeed, with bonuses based on short-term profits, they had every incentive to gamble and connive. And now that there’s a bust, no one is being asked to pay back the hefty bonuses earned during the boom.* On the contrary, even as they are dismissed, those who helped send their firms and the American economy into a tailspin are rewarded with generous severance packages. They are enriched regardless of what happens to investors, homeowners, and others who lost so much. Unless we reform incentives, the financial sector will only try to circumvent whatever new regulations are put in place.

Having made so many others financially insecure, those who grabbed while the getting was good are relatively even better positioned to fund campaigns and the 527s now scurrying to stop a Democratic supermajority. One wonders, for instance, why the British plan to prop up their banking sector demanded a 12% rate of return for taxpayers and influence over the use of funds while the US plan only generally demands 5% and offers government little more than moral suasion over how the funds are allocated.

(And that moral suasion isn’t working too well–Morgan Stanley appears to be set to give out even more bonuses, and it’s by no means clear that a big proportion of the US bailout won’t be squandered on massive executive compensation, dividends, and mergers.)

One hope here is that as fraud cases accumulate, some sort of settlement will be reached to help stop the pattern of socialized risk and privatized gain. Just as Fannie and Freddie were forbidden to lobby, Wall Streeters’ ongoing efforts to skew the bailout in their favor should lead to scrutiny of their political spending. Given the crisis, outright bans on their political spending might be considered, First Amendment considerations notwithstanding–as Judge Posner never fails to remind us, the constitution is not a suicide pact. Corrective justice also suggests we spend less time waving the threat of prison at those investigated, and more on crafting settlements that recover for the public purse some portion of the billions of dollars of bonuses this fraudulent paper generated. If we fail to do that, Madeleine Bunting’s indictment of the system will only ring more true:

Those who will pay the heaviest price for the foolhardiness of deregulated financial capitalism are among those who are least responsible, as Brazil’s President Lula angrily pointed out last week. The shockwaves of the west’s banking crisis will shipwreck more vulnerable countries. In developing countries, people don’t have the resources – welfare provision, savings, insurance – to tide them over a crisis. Instead, they go hungry, homeless – and they die.

Those who made fortunes creating this mess deserve to pay for cleaning it up. And before such an idea is dismissed as hopelessly complex to implement, perhaps we should consider re-assigning the IRS agents now charged with scrutinizing, Inspector Javert style, some EITC recipients’ hundreds of dollars of fraud, to the investigation of the real basis of Wall Street’s hundreds of millions of dollars of wealth.

Frank is Professor of Law at the University of Maryland. His research agenda focuses on challenges posed to information law by rapidly changing technology, particularly in the health care, internet, and finance industries.

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